Greece's Problem Is Everyone's Problem

Edward D. Hess

March 10, 2010, 2:51 PM EST

Why is Greece's current financial problem everybody's problem? Not just because what happens anywhere in the global economy affects what happens everywhere else. Rather, the attitudes and tactics that helped Greece hide its debt through questionable short-term reporting and financing instruments also lurk at the foundation of other countries' and companies' finances. This is a global business issue.

Recent reports reveal how Greece obscured its mounting debt through financial derivatives, hiding debt transactions as currency trades. Like the subprime securitization game, these instruments created the illusion of solvency—an illusion that finally was exposed to the harsh light of reality. Egregious, yes, but not fundamentally different in philosophy from the kinds of short-term tactics that lead some CEOs and CFOs to push their companies' problems into the future in return for happy quarterly earnings reports.

Just like companies, countries compete for global investment capital. And just like companies, countries under external and internal pressures may be tempted to play games with the numbers. In the U.S., widespread acceptance of illusory, non-authentic earnings threatens the long-term vitality of the American economy. We have seen French and British banks taking big derivative and securitization risks, too. For any country, and any company, these short-term tactics ultimately can stifle growth and innovation and can weaken the chances for a full global economic recovery.

Dangers of Short-Termism

Many businesses are hooked on quick fixes and phantom solutions. Short-term interests dominate the U.S. and British capital markets, for example, and actively hinder the possibility of real growth. Nearly 70% of the stock in U.S. corporations is owned by institutions, which on average hold such shares for 12 months or less.

Executive compensation tied to quarterly earnings and pressure to demonstrate higher earnings each reporting cycle from Wall Street and the City of London also stacks the deck in favor of short-term results. But with chief executive tenures at large public companies now averaging less than six years, CEOs are rarely around to take responsibility for the long-term effects of their short-term decisions.

As Thomas J. Donohoe, president of the U.S. Chamber of Commerce, put it several years ago: "We've created an environment where a company's long-term value and health are all too easily sacrificed at the altar of meaningless short-term performance." As a consequence, neither the people who run many of our biggest corporations, nor those who invest in them, are motivated to care about the long-term interests of a company and the entire ecosystem it touches—employees, suppliers, and customers.

Pursuit of Illusory Earnings

The consequence of Wall Street pressure to meet earnings expectations pushes companies to spend time, money, and intellectual capital creating or manufacturing wasteful and distorted non-authentic earnings that do not represent real growth or innovation.

What exactly are "non-authentic" earnings? They are the non-operational numbers created by accountants and investment bankers: valuation estimates, accounting adjustments, investment transactions, channel stuffing, and other financial engineering tactics. They have the same effect on a company's stability as Greece's "non-loan loans" had on its credibility.

Although in most cases the machinations needed to demonstrate continuous growth in quarterly earnings are legal, they are illusory numbers because they do not represent the fundamentals of a business that are important for long-term viability and competitiveness.

Authentic earnings, on the other hand, are an indicator of the strength of a company's customer value proposition. They represent the sale of more value-add goods and services on customary commercial terms to unrelated customers in arms-length transactions. Authentic earnings are superior indicators of growth because they represent information about the underlying vitality, differentiation, and market acceptance of a company.

Changing the Rules of the Game

"Greed is not self-correcting," writes former Senator and University of Colorado professor Gary Hart in a recent blog on the topic of the investment bankers who helped Greece manipulate its national budget to conceal real deficits. Some of the rules of the game need to be changed, beyond government interventions that only encourage more short-term, illusory fixes.

The global economy needs real growth and innovation, and those are not short-term goals. The systemic dominance of short-term players and a quarterly mentality hinders and penalizes real growth and innovation. To change the rules of the game in a way that reaches down to the structural flaws in the current system, several concrete steps can be taken.

First, public companies should be required by regulators, listing exchanges, and their boards of directors to disclose with complete transparency their non-authentic earnings.

Second, in the U.S., the short-term renting of stock should be discouraged by increasing the holding period for long-term capital gains to three years and imposing fees on nontaxable institutional short-term stock renters, as well.

Third, executive compensation should be more properly aligned with the long-term creation of real growth.

Finally, public companies should be made to disclose their short-term and long-term growth portfolios, so long-term investors can better evaluate and allocate their capital to smart, rather than apparent, growth.

Ignore the Siren Song

Awareness of different models of success is also important. Change is unlikely without a few pioneers of the long view blazing the way. It takes a degree of courage for a CEO such as Costco's (COST) Jim Senegal, for example, to stand up to Wall Street criticisms of the manner in which his company manages itself for the long-term satisfaction of customers and employees.

Wall Street, Senegal once said, is "trying to make money between now and next Thursday. We're trying to build a company that's going to be here 50 to 60 years from now."

Greece's unfortunate difficulties are likely to have long-term effects. That should be a warning sign to all companies lured by the siren song of short-term earnings. At stake is the ability of companies and entire nations to generate a new era of authentic growth.

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